The ECB's 2026 Dilemma: Hike Rates Into a Slowdown, or Let Inflation Expectations Drift?

One month ago, energy prices were falling, eurozone inflation sat comfortably at 1.9%, and the European Central Bank was on track to hold interest rates steady through most of 2026. Then came the Iran war.

Eurozone inflation surged to 2.5% in March, up sharply from 1.9% in February, driven by an 8-percentage-point turnaround in energy inflation — from a 3.1% annual decline in February to a 4.9% annual increase in March. Brent crude has climbed above $110 per barrel. European gas prices are up roughly 80% year-to-date. And the Strait of Hormuz remains largely closed.

Portugal's inflation accelerated to 2.7% in March, up from 2.1% in February, matching the broader eurozone pattern.

Markets have moved decisively ahead of policymakers. As of Tuesday, traders price a 36% probability of an ECB rate hike in April, 76% for June, and 84% for at least one hike somewhere in 2026. Yet ECB President Christine Lagarde has signaled a wait-and-see approach, stressing that the central bank will be guided by data, not forecasts.

So what happens next? Will the ECB hike rates into a weakening economy to prevent inflation expectations from drifting — or will it hold steady, betting that this energy shock, like the one in 2022, will eventually pass without leaving a lasting mark?

Core Inflation Fell — But That May Not Last

The single most important detail in Tuesday's inflation data is this: core inflation — which strips out energy, food, alcohol, and tobacco — actually declined to 2.3% from 2.4%. Services inflation eased from 3.4% to 3.2%. Non-energy industrial goods inflation fell from 0.7% to 0.5%.

This is what economists call a first-round energy shock: oil and gas prices spike, but those increases haven't yet spread to wages, rents, and the broader basket of goods and services that people buy.

The question is whether it stays that way.

ING's Global Head of Macro Carsten Brzeski has identified three thresholds that could force the ECB to act: headline inflation above 4%, core inflation above 3%, or a sustained rise in survey-based inflation expectations. None of those has been breached — yet.

But consumer inflation expectations in the eurozone surged to 43.4 in March from 25.8 in February — the sharpest monthly jump in years, according to European Commission data. If that trajectory continues, Brzeski's credibility trigger comes into play fast.

Prediction markets on Polymarket now price a 61% probability that eurozone inflation ends 2026 above 3.1%, and an 85% probability it finishes above 2.8%. That's well above the ECB's 2% target — and a clear sign that traders don't believe this shock will fade quickly.

The 2022 Parallel — and Why This Time Is Different

The comparisons to 2022 are inevitable. Back then, the ECB delayed raising rates until inflation was already entrenched, forcing a painful catch-up cycle that saw rates rise from -0.5% to 4% in just over a year.

This time, the starting point is different. Gas prices have risen 80% year-to-date, yet average wholesale electricity prices for the five largest eurozone economies are still below their January levels, largely because renewables and nuclear are displacing gas at the margin, according to BNP Paribas economists Stéphane Colliac and Guillaume Derrien.

The labour market is also weaker. Bank of America economist Ruben Segura-Cayuela notes that unemployment has already begun ticking up in several member states, and consumer confidence has cratered. The ECB's own forecast now expects just 0.9% eurozone growth in 2026, down from earlier projections of 1.3%.

But there's a counterargument: because households and firms still remember 2022 vividly, their behavioural response to this new shock may be faster and more amplified than historical models would predict. Workers may demand higher wages preemptively. Firms may raise prices sooner to protect margins. And if that happens, the ECB will have waited too long — again.

April: Unlikely. June: Increasingly Probable.

Most economists expect the ECB to hold rates steady at its April 17 meeting, giving policymakers more time to assess whether the energy shock is broadening into core inflation.

But if oil stays above $100 per barrel, the Strait of Hormuz remains largely closed, and inflation expectations continue rising through May, a June rate hike becomes the base case.

ABN AMRO analysts expect two insurance hikes this summer — 25 basis points each in June and July — designed to anchor inflation expectations before wage negotiations in the autumn lock in higher pay growth.

BNP Paribas sees a similar path: assuming Brent stays above $100 through Q2, they forecast cumulative hikes of 75 basis points by autumn, bringing the deposit rate from 2.0% back to 2.75%.

Bank of America puts the probability of an April hike as possible, but less certain, but sees a couple of hikes this summer (June and July) as likely under a persistent energy shock scenario.

What This Means for Portugal

For Portuguese households and businesses, the stakes are high. Mortgage rates, which had been falling steadily since mid-2024, are now likely to rise again if the ECB tightens policy. That comes at a moment when housing affordability is already under severe strain: INE data released last week showed Portuguese home prices surged 17.6% in 2025, the highest annual increase ever recorded.

The eurozone-wide energy shock also raises questions about Portugal's growth outlook. The Bank of Portugal has already slashed its 2026 growth forecast to 1.8%, citing weaker consumer confidence and higher energy costs. If the ECB hikes rates twice this summer, that forecast could fall further — potentially below 1.5%.

At the same time, inflation at 2.7% erodes real incomes, particularly for households on fixed wages or pensions. If wage growth doesn't keep pace — and there's little sign it will, given the weakening labour market — purchasing power will continue to deteriorate.

The Road Ahead

The ECB now faces the same dilemma that haunted it in 2022: tighten policy to anchor inflation expectations, or hold back as the economy weakens beneath the shock.

March's data confirms that price pressures are resurfacing — but they have not yet broadened decisively beyond energy. Core inflation fell. Services inflation eased. That gives the doves on the Governing Council just enough cover to argue for patience at the April meeting.

But patience has a shelf life. If the Strait of Hormuz remains largely closed, oil stays above $100, and core inflation begins drifting higher in the months ahead, the ECB will have little choice but to act.

The question Frankfurt must answer is not whether it is willing to hike — Lagarde has already made that clear. It is whether it can afford to wait until the damage is visible in the data, or whether the ghosts of 2022 will force it to move before the evidence is fully in.

For now, markets have made their bet: inflation is coming back, and the ECB will have to act. Whether Frankfurt agrees will become clear in the weeks ahead.